Sandy M. Kaplan | JAMS
Commercial and residential construction projects expose property owners and general contractors to significant risks arising from personal injury, property damage and construction defect claims. Contract documents can help allocate those risks to the responsible parties, while insurance can protect against losses that cannot be avoided or fully transferred. Common risk management tools include contractual indemnity, prevailing-party attorneys’ fees provisions, insurance requirements and early alternative dispute resolution (ADR) clauses.
Contractual Indemnity
Contractual indemnity is one of the most common means to transfer risk from one party to another. A common indemnity provision in construction agreements provides that one party (the indemnitor) agrees to defend and/or indemnify another party (the indemnitee) for attorneys’ fees, damages or other losses arising out of the indemnitor’s work or negligent conduct. Such indemnity provisions are allowed in almost every state and can be found in many American Institute of Architects (AIA) and other industry contracts.
More aggressive indemnity provisions will require the indemnitor to indemnify the indemnitee for the indemnitee’s own passive or active negligence. Such indemnity provisions provide significantly greater protection to the property owner and/or general contractor by transferring the risk of loss to a contractor or subcontractor for the indemnitee’s own work or conduct. However, many states have passed anti-indemnity statutes, which limit the scope of indemnity agreements and do not allow for the indemnitor to seek indemnity for its own actions. In California, for example, there are different limits on the scope of indemnity agreements for commercial and residential construction, and statute does not allow for the indemnification of the indemnitee’s own active negligence. Because these limitations vary by jurisdiction, practitioners should review the applicable state law when drafting or evaluating an indemnity provision.
Prevailing-Party Attorneys’ Fees
Attorneys’ fees, expert fees and related costs may be significant in litigation and arbitration matters. The transfer of attorneys’ fees and expert costs from one party to another is an additional risk transfer tool. While states do not generally allow for the recovery of attorneys’ fees unless specifically allowed by statute or contract, contractual attorneys’ fees provisions are used to allow for the prevailing party to recover its own attorneys’ fees and costs in litigation or arbitration. These provisions are written to allow the prevailing party to recover all fees and costs incurred, or “reasonable” fees and costs, from the non-prevailing party. Under such wording, the court or arbitrator will make an independent determination as to the reasonableness of fees and may also be required to determine which party prevailed. Practitioners should consider including a clause stating that the party that prevails on the majority of issues will be deemed the prevailing party for the award of attorneys’ fees.
Before including a prevailing-party attorneys’ fees clause in a contract, parties should be aware that many current general liability insurance policies may not cover the award of attorneys’ fees as an insurable damage. Nonetheless, the right to recover attorneys’ fees and costs is a powerful risk-allocation tool.
Insurance
Insurance is perhaps the most common way to transfer construction risk for personal injury and property damage claims. General liability insurance, builder’s risk insurance, professional liability coverage, subcontractor default insurance and bonds are all tools that can be used to transfer significant construction risk to a third-party insurer or surety and protect against unanticipated loss. The construction contract should specifically set forth the insurance obligations of all parties and establish a process for confirming that the required coverage is in place.
Additional insured endorsements
The most common means for a property owner or general contractor to transfer risk for personal injury, property damage and construction defect claims is to be named as an additional insured on the subcontractor’s or general contractor’s general liability insurance policy. However, there are many additional insured endorsements that provide different levels of coverage. Some policies provide a blanket additional insured endorsement that automatically provides for coverage if the written contract requires it. Under these circumstances, it is imperative that the contract terms require the property owner and general contractor be named as additional insureds. Other, more limited additional insured endorsements provide coverage only for ongoing operations (ISO Form CG 20 10), while broader additional insured endorsements provide coverage for both ongoing and completed operations claims (ISO Form CG 20 37). Accordingly, the contract should specify the required additional insured coverage.
Payment of deductible or self-insured retention
Many insurance policies have a deductible or self-insured retention that must be satisfied either before the insurance company will defend the case or after the case is over. The size of the deductible or self-insured retention may vary greatly. In drafting the construction contract, the property owner or general contractor should be aware of the size of the deductible or self-insured retention and may choose to require the party responsible for the loss to satisfy all or part of a deductible or self-insured retention. This often occurs in projects which the property owner or general contractor chooses to insure the project through a wrap-up program and enrolls all contractors and subcontractors in the builder’s risk policy. If the contract is silent as to who shall satisfy the deductible or self-insured retention, the obligation to pay the insurance often falls on the first named insured.
Early ADR Provisions Can Reduce Costs and Disruption
The inclusion of a mandatory early mediation or ADR provision is a useful way to resolve conflict before litigation or arbitration is instituted. Under these provisions, the parties are required to first meet and confer with each other and then participate in a nonbinding mediation before a party may initiate litigation or demand arbitration. The contract should specify whether the cost of the mediation will be shared equally between the parties or one party will bear the full cost.
Risk transfer is a common way for a property owner or general contractor to save money by transferring liability and the cost of litigation to the party responsible or an insurance company. The effectiveness of these tools depends on clear drafting and alignment between contractual risk-allocation provisions and available insurance coverage.
When one of your cases is in need of a construction expert, estimates, insurance appraisal or umpire services in defect or insurance disputes – please call Advise & Consult, Inc. at 801.641.8304, or email experts@adviseandconsult.net.